Amid high uncertainty and conflicting forecasts for markets and interest rates, several analysts made the same suggestion.
This is the first in a new series of columns about portfolio strategies and planning.
The flurry of market predictions that pour in from Thanksgiving to New Year’s are starting to arrive, with visions of 2024 interest rate cuts and stock gains, and maybe a mild recession, likely to dance across many strategists’ headlines in the coming days and weeks.
Uncertainty has been a keyword for markets and the economy since the pandemic, though, and investors hoping to plot a course for next year based on analysts’ forecasts and Federal Reserve tea leaves may find it difficult to sift through differing views on what might happen and when.
Will there be a soft landing/? No landing? More interest rate hikes to rein in stubborn inflation? Long-awaited rate cuts to signal a clear end to the Federal Reserve’s aggressive, inflation-fighting policies?
While financial advisors and clients indeed could find the right forecast to align with their own instincts and insights, or pull their hair out trying to figure when the macroeconomic environment will shift, some strategists suggest another tack: Focusing on high-quality investments.
UBS’s chief investment office, for example, says investors shouldn’t expect the U.S. economic and interest-rate path to be smooth in 2024.
“We agree with the market’s assessment that U.S. growth, inflation and rates will all head lower next year — but our view on the timing and size of U.S. rate cuts differs to the market, with potential for uncertainty and market volatility,” Solita Marcelli, chief investment officer Americas, UBS Global Wealth Management, and colleagues wrote in a research note this week.
“So, we believe investors should focus on quality. In fixed income, quality bonds offer attractive yields and should deliver capital appreciation if interest rate expectations decline as we expect. In equities, quality companies with strong balance sheets and high profitability, including those in the technology sector, should be best positioned to generate earnings in an environment of weaker growth.”
The outlook for U.S. interest rates in 2024 remains a crucial driver of asset markets now, the UBS team said, noting that dovish comments this week from a typically hawkish Fed governor caused the markets to nearly double their estimates for a rate cut as soon as March and helped drive down 2-year U.S. Treasury yields.
Growing market confidence that the Fed has tamed inflation and will be able to cut borrowing costs earlier than expected also has driven the S&P 500 index to near its year-to-date high, UBS suggests. But the firm noted other Fed officials have remained cautious in their approach, with at least one signaling the central bank will need to raise rates again to press inflation to its 2% target.
U.S. economic data continues to send mixed signals, UBS notes, cautioning that the Fed’s data dependency and diverse opinions could translate into more changes in rate expectations and therefore more market volatility in this year’s closing weeks.
“Since we anticipate continued volatility across markets and economic data due to inflation crosswinds, we recommend investors look for quality across asset classes. We forecast positive returns for both quality fixed income and equities over the next six to 12 months, making it a good time to add to diversified balanced portfolios,” the UBS team wrote.
They’re not alone in the quality focus.
Charles Schwab Chief Investment Strategist Liz Ann Sonders for months if not longer has recommended investors focus on quality and look for companies with low debt, high cash levels and positive earnings revisions and surprises.
Finding Quality Stocks
GMO, the investment firm that strategist Jeremy Grantham co-founded, also emphasizes quality, and recently launched its first ETF, which focuses on high-quality U.S. stocks. The firm introduced a quality strategy nearly two decades ago after years researching quality portfolios.
“Through market cycles and dislocations, high-quality equities have proven to be a stable group of exceptional businesses ideally suited to compounding capital. While equity styles go in and out of favor, quality companies continue to serve clients as a core holding, resilient to economic headwinds and market drawdowns,” the firm said in a three-year-old paper it reposted this month.
When Grantham and partners founded the firm in the late 1970s, he faced the “conundrum that high-quality business models are difficult for value investors to own because they tend to trade at premiums to the market,” author Kim Mayer wrote.
Grantham’s research team found three key identifiers in a company’s financial history that indicate sound business models, according to Mayer. “Companies with a record of high profitability, stable profitability and low leverage are most apt to be able to continue to grow at high rates of return throughout the business cycle and in various economic environments.”
Over time GMO realized that “the quality group of companies was a distinct third factor, or style, alongside value and growth and could be equally predictive of future return expectations.”
Quality stocks moved independently of growth and value stocks during the dot-com bubble and by the early 2000s, when large-cap growth stocks remained expensive and value stocks had caught up, quality stocks had an attractive return forecast, Mayer wrote.
“For long-term investors searching for a durable equity solution,” he said, “we believe quality is ‘the real McCoy.’”